The Hindu Business Line : Economics of advertising

MY FRIEND, a cricket enthusiast, is glued to the television these days. He realises that he is able to watch these matches live because of corporate sponsors. He, however, wonders why companies spend so much on advertisements. What is the economics behind the `extravagant' advertisements?

How do you convince potential customers that your product is better than that of your competitors'?

Advertisements help companies signal to the potential customers that their product is of good quality. How? You may hire Bollywood stars to advertise your product. That will cost a fortune and even deplete your company's cash flows. Some, like my friend, may consider such a measure a waste. Students of economics may, however, see some merit in such spending. Why? Spending crores of rupees to hire Bollywood stars to advertise your product is a show of confidence in product quality. Would you spend crores of rupees otherwise? If you are insincere about product quality, you risk not recovering the advertisement cost, as your customers will not consume your product again.

Extravagant advertisements send strong signals to potential customers. There is, indeed, an economic rationale behind a company hiring top stars to sell a mundane product. Of course, being confident of the product quality does not necessarily mean that your business will be successful. There could be instances when the product may fail to attract any demand despite the strong signals you may send through advertisements.

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